Financial Update (April-June 2001)

Greenspan Touts Virtues of Prudent Lending Practices

peaking to the Community Bankers of America in March, Federal Reserve Chairman Alan Greenspan encouraged bankers to maintain vigilance against lax credit standards and noted that the problem loans that have surfaced on banks’ balance sheets during 2000–01 illustrate the virtues of sound financial practices.

While he said that many bankers lend aggressively at the peak of a business cycle, he believes that “a more disciplined, less pro-cyclical, long-term approach to lending that provides higher average risk-adjusted returns to shareholders” is in the self-interest of banks. But Greenspan also stressed the importance to institutions that “in their zeal to make up for past excesses they do not overcompensate and inhibit or cut off the flow of credit to borrowers with credible prospects.”

The current lending environment

Though underwriting practices appear to be much healthier today than they were in the 1980s and standards have tightened somewhat recently, supervisors are paying particular attention to community banks with concentrations, such as commercial real estate, that may make them more vulnerable to a downturn, Greenspan said.

He also said that fewer deposits and a rising demand for loans have recently pushed liquidity benchmark ratios, such as loans to deposits, to historic peaks for community banks. He noted some signs of relief, however, as demand for loans by businesses and consumers is moderating and consumers are beginning to return to bank retail deposits in the wake of disappointing financial market returns.

Know what you’re getting into

Greenspan said that many of these liquidity pressures are likely to remain, however, encouraging community banks to explore nondeposit liabilities to fund asset expansion. But he cautioned community banks to make sure they fully understand complex funding products, especially those embedded options that cause cash flows to change dramatically based on market conditions.